Fiscal strategy : The Smith Manoeuvre

Discover how you can deduct interests payed on your mortgage or other financial assets from your taxes ?

A stategy to lower your tax burden

The Smith Maneouver consists in restructuring your loans in a way that allows you to deduct interest charges from your taxes. Thus, if you own investments in a taxable account (not in an RSP) and a mortgage for which interests are not tax-deductible, it is possible to restructure your assets in a way that makes it all possible.

In this case, interests paid on borrowed money and used with the goal of earning business or asset-linked revenues can be deducted from revenues of all types. In other words, the interests charged from a loan used to purchase stocks, mutual funds or other invesments can become tax-deductible as long as their is a reasonable expectative, when purchasing the invesment, that the owner will receive dividends or interest income from the invesments.

It is not always easy to establish the necessary link between borrowed money and it's real use. Below is a frequently used procedure that the CRA (Canada Revenue Agency) has admitted it would allow, depending on situations, in order to deduct interest expenses :

Debt reorganization

The owner of a taxable investment portfolio could liquidiate them and use the sales proceeds to reimburse his residential mortgage for which interests are not tax-deductible. Following that, he could borrow again an amount directly from the mortgage and give his house as collateral. Once these operations are completed, he could then use the loan on the house to purchase investments in a taxable account that have a reasonable expectative to earn revenues such as interests or dividends. In this case, the interests on the loan would be tax-deductible.

I hope this article is useful to you. Do not hesitate to let me know of any question on this matter. It is howerver recomanded to consult with you accountant or fiscalist to find out if this type of strategy could be suitable for you.

Source : Guide du conseiller en financier, édition 2008, Denis Lapointe